Government control, regulatory enforcement actions, and the cost of equity

Abstract

Using a comprehensive manually collected dataset of regulatory enforcement actions againstfraud in the Chinese capital market and a difference-in-differences (DID) research design, we examine theimpact of such actions on the implied cost of equity and the role of the government as the controlling share-holder in moderating this relationship. We find that regulatory enforcement actions increase firms’ cost ofequity, and that government controlling shareholders can mitigate the effect of these actions. Our resultsare robust to various sensitivity tests, including alternative measures of the cost of equity, alternative sam-ples, additional control variables, and an alternative DID design. Additional analysis provides supportingevidence that the effect of enforcement actions on the cost of equity arises from investors’ perception ofhigher long-run information risk in the case of fraud firms. Further, government controlling shareholderscan mitigate the impact of such actions on the cost of equity by lowering investors’ perceived informationrisk Show more